What to expect from the next market correction

Commentary: Dow’s ups and downs show a clear long-term trend

By

JohnPrestbo

NEW YORK (MarketWatch) — Stocks have been outpacing the lethargic economic recovery and therefore are vulnerable to a pullback, according to more than one market maven. Of course, another contingent of pontificating pundits proclaim even better days ahead.

All of this chatter got me wondering how often the market corrects and, when it does, by how much?

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Historically, the market has trended upward. Occasionally, such as during the 1950s and 1990s, the gains are strong and persistent. More often the market meanders, taking one step down for every two it moves up. And sometimes the market tumbles through rapids or, rarely but memorably, over cliffs. (See 2008.)

To sort out this mixture of behavior, I traced the Dow Jones Industrial Average
DJIA, -1.11%
from the end of 1945 to the present. Pullbacks of less than 5% were so common I gave up counting them. Instead, I focused on drawdowns of at least 10% but less than 20%, which is the range many call a “correction,” and of 20% or more, the usual definition of a bear market.

By my count, there were 27 corrections and 12 bear markets during the 66+ years examined. The more than two-to-one ratio of corrections to bears seems intuitively right. Taken together, they indicate the market hits a pothole of one size or another about every 20 months on average.

These mishaps aren’t spaced so evenly, of course. The 1970s — a decade in which the market went nowhere — accounted for nearly a quarter of the combined corrections and bear markets. Another 20% of them occurred in the “lost decade” of 2000-2010.

Corrections produced an average decline of 13.3% over 71.6 trading days, which is about 14 calendar weeks or a week longer than one quarter. Since this century began, the average of five corrections is a decline of 14.4%.

The shortest correction (of 12%) lasted 15 trading days, ending in mid-July 1950. The longest (of 14.9%) stretched agonizingly over 193 days (39 calendar weeks), ending in mid-October 2000. So far in this century the average length is 87.83 trading days, or 17 calendar weeks.

The dozen bear markets averaged declines of 27.9% over 154.3 trading days, which is about 31 calendar weeks. The range was from 20.1% (in 1973) to 52.3% (2008). There have been three bear markets in this century (the dot-com implosion produced two, not one, with a 30% recovery in between). Their average plunge was 37%, thanks to the most recent one; the (relatively) mildest was a 27.4% drop in 2001.

That 20.1% sinkhole in 1973 was a bear-market express, taking just 28 trading days or a little over five calendar weeks. The most elongated bear (a 26.9% retreat) dragged out over 363 trading days, or one year and four months. That ordeal, created by economic “stagflation,” ended in early 1978. This century’s bears have averaged 180 trading days, or about nine months.

Coming retractions

These pullback box scores give a sense of what may lie ahead in the market, but not when it could happen. For that we turn to the market rallies, which I define as sustained increases without an interrupting correction. Of course, the rallies overcame many less-than-10% slips along the way

Since 1945 there have been 58 such bull runs by my count, averaging gains of 32% and lasting 221 trading days (or roughly 10 months). So far in this century, nine rallies advanced an average 33.8% and continued an average of about one calendar year.

The Dow’s most recent correction was a 15.9% slide from 12810.54, the close on April 29, 2011, to 10771.48 on September 23 of that year. (The most recent low close of 12101.46 on June 4, 2012, doesn’t count as a correction because it marked an 8.9% decline from the preceding high close.)

The Dow’s climb since September 2011 is much longer than average. No wonder the correction carpers are getting strident. If a correction has begun, starting with the recent high close of 14009.79 on Feb. 1, and if it progressed by exactly this century’s averages, the Dow will close at 11992.38 soon after Memorial Day.

That’s much too precise for a computation based on ifs, to be sure, but history is not the least-reliable guide to the market’s next twists and turns.

John Prestbo is retired as editor and executive director of Dow Jones Indexes, now part of S&P Dow Jones Indices, in which Dow Jones & Co., publisher of MarketWatch, holds a small interest.

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